For a 46% return, bond investors go to Venezuela—If they dare
by Wall Street Journal
October 24, 2016 | 6:00 pm| | | Start Conversation
Venezuela is plagued by widespread hunger, skyrocketing infant mortality and 500% inflation. Yet its sovereign bonds are the best performers in emerging markets this year, delivering investors a return of 46% through Friday.
The government of President Nicolás Maduro continues to pay billions of dollars annually to service Venezuela’s debt, even as it is unable to import enough food and medicine. The situation has polarized emerging-markets investors. Some large fund managers are doubling down on Venezuelan bonds for their high yield. Others are avoiding the country altogether, because they believe default to be inevitable.
Fidelity Investments owns at least $1.8 billion in face value of bonds issued by Venezuela and state-owned oil company Petróleos de Venezuela SA, or PdVSA, according to fund tracker Morningstar Inc. The asset manager’s emerging-markets fund, 7% of which is invested in Venezuelan debt, has returned 16.7% this year, about 3 percentage points more than comparable mutual funds, according to Morningstar.
The $6.2 billion T. Rowe Price Emerging Markets Bond fund had 7.9% of its assets in Venezuelan debt as of the end of September, mostly in PdVSA bonds due this year, and has returned 17.6% this year through Friday.
The government oil company, whose bonds account for about half of what is regarded as the country’s sovereign debt, in recent weeks asked owners of its near-term bonds to exchange them for debt maturing in 2020 but has struggled to persuade even half of the bondholders to swap.
Michael Hasenstab, who manages Franklin Templeton’s $42 billion Templeton Global Bond Fund, sold out of the oil-rich country’s debt in 2014. His fund has paid a price, returning just 1.89% this year.
“It’s a mystery to us how and why they chose to service their external debt,” Mr. Hasenstab said.
About a third of the emerging-market bond funds that Morningstar tracks have no exposure to Venezuela, despite its 2% weighting in a widely followed benchmark.
Venezuela faces $15 billion of bond payments by the end of 2017 and has foreign reserves of about $12 billion. With approximately $65 billion of government and PdVSA bonds outstanding, a default could have widespread political and financial consequences.
Buyers of the country’s bonds are betting it will continue paying to keep bondholders from trying to seize overseas assets, including oil shipments, which are the lifeblood of the deeply unpopular Maduro government.
“The cost of them to default on the debt is much higher than any benefits they will receive by defaulting on the debt,” said James Craige, head of emerging markets at Stone Harbor Investment. “I expect them to understand that.” He declined to comment on the firm’s holdings.
The Venezuelan capital of Caracas was a Latin American financial hub in the 1980s, full of gleaming skyscrapers and energy companies eager to exploit the largest national oil reserve in the world. But oil-boom profits disappeared by the 1990s when crude prices fell, while corruption and cronyism discredited the two entrenched parties. In 1998, Hugo Chávez rode to power on a wave of populism. His socialist overhaul, though, sent the Venezuelan economy into a tailspin that his successor, Mr. Maduro, has made worse.
To save scarce dollars for bond payments, the government is halting basic infrastructure maintenance and abandoning subsidies on food and services, making life increasingly difficult for ordinary Venezuelans and fueling runaway inflation.
A kilogram of rice now costs a quarter of the weekly wage of a nurse or a schoolteacher, forcing more than half of Venezuelans to skip meals daily, according to the latest polls.
“We’re slowly starving here,” said José Luis Javier, a barge captain in the eastern city of Güiria. “All the dollars are gone.”
It all adds up to one of the most complex sovereign-debt crises in recent memory, saidAnna Gelpern, a law professor at Georgetown University and fellow at the Peterson Institute for International Economics. The last time a government prioritized foreign debt payments over food, she said, was in Romania during the 1980s under communist dictator Nicolae Ceausescu.
While there is always uncertainty in sovereign-debt crises, they tend to follow a predictable playbook. When investors stop buying new bonds from a country—as they did in Argentina, Greece and now Venezuela—its leaders ask multilateral lenders such as the International Monetary Fund for emergency cash. Those agencies usually demand economic reforms in exchange for new loans and often require bondholders to share in the pain through bond swaps that involve debt relief.
But Venezuela hasn’t dealt with the IMF since former President Chávez broke with the fund in 2007. Instead it has relied on China for about $50 billion in oil-backed loans. China has increasingly become the lender of last resort to commodity-rich emerging markets but it is secretive about the terms of those agreements, heightening uncertainty for investors.
For some investors who are sticking with the country’s debt, the bet is that the country’s regime can’t last much longer. “Some sort of political change will happen,” said Simon Lue-Fong, global head of emerging debt at Pictet Asset Management, which has $21 billion in emerging-market debt.
Such investors believe Venezuelan assets will be re-evaluated once a new government takes office and potentially opens the door for help from the IMF. With huge oil reserves underground, the country has huge upside potential, they argue.
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